Dispelling Myths #3 and #4: “Extraordinary popular delusions and the madness of crowdfunding”

Note to readers: This post is part of a series of posts written on behalf of Canada’s leading industry crowdfunding association, NCFA Canada, its members, and affiliates. Special thanks to our sponsors Joi Media (Katipult), FundRazr, Amplifi, CNW, and Wires Law, and the following contributing thought leaders including Craig Asano (NCFA Canada), John Wires (Wires Law), Christopher Charlesworth and Asier Ania (HiveWire), and Heri Rakotomalala (Seeding Factory).

On July 31, 2013 an opinion post article in the Financial Post’s comment section highlights the wide disparity in thinking between the established finance industry insiders and the rest of the world (view article).

It appears the world can be divided into two camps:

Camp A: Those that feel the general public or ‘crowd’ should have little or no participation in private market placements because they are thought unfit or incapable of adding value to the process, and the regulations required to protect them would duly outweigh the benefits they may receive from participating in the first place. Further, investing in start-up or growth capital investments is a risky game that should be left to professional VCs and sophisticated investors alone.

Camp B: Those that feel the general public or ‘crowd’ should have the choice to participate in private market placements in a regulated capacity, and that the general public is motivated to seek returns that go beyond financial incentives alone, such as supporting innovation, regional job creation and social impact goals. Equity crowdfunding markets globally have demonstrated that crowds can play a significant role in helping small to mid-sized enterprises (SMEs) access start-up capital and the necessary support to achieve business goals that would otherwise be unavailable to them in traditional capital markets.

To assist readers in making their own unbiased conclusions, NCFA Canada offers readers a response to the myths or one-sided beliefs that were conveyed in the FP article:

Myth 3: VCs and wealthy angels will not invest in companies with ownership structures that have many minor investors in them

Canada can learn from legal structures being used overseas to successfully facilitate equity crowdfunding

In the Netherlands, Symbid, a leading equity portal bundles all crowd investors of each successfully funded business into an investor co-operative, which acts as a single shareholder within the legal entity of the entrepreneur.

With this model, VCs that participate in follow-on investment rounds only deal with a single elected Board member.

This offers the best of both worlds: the benefits of wide resources and crowd participation combined with streamlined decision making capabilities.

In the UK, Seedrs, a leading equity crowdfunding portal, uses a nominee structure where crowd investors appoint the platform itself to hold legal title of the securities on behalf of crowd investors who are still able to vote but are relieved of the burden of investment administration such as tracking corporate events, attending meetings and following investment performance.

Many VCs openly support equity crowdfunding as a means to fund early stage businesses that feed into wide venture capital markets

There are many venture capitalists in Canada that openly support the inevitability of equity crowdfunding (e.g., Chris Arsenault's blog) as a way to fund high risk earlier stage of start-up businesses to the point that they have demonstrated sufficient traction and management ability before getting snapped up by a VC in a future round.

They indicate that crowd investors are already participating in deals through angel investment matching networks, such as Angel List in the US.

Crowdfunding is a feeder system to a much wider venture capital network, and we can only expect to see more partnerships forming as more fundraising activities are moved online.

Myth 4: High Risk of Business Failure and Fraud

RESPONSE 4: The crowd will help to detect and report fraud. Businesses will fail but some will iterate and achieve tremendous innovation through failure

Fraud and business risks can be identified and mitigated with education and technology

Fraud in any area of the financial system should not be tolerated, and crowdfunding is no different. Industry stakeholders, government and academic partners need to collaborate to actively identify, report and prevent fraudulent activity and develop the appropriate safeguards to protect and advance the industry full stop.

Fraud and business failure isn’t limited to private companies. Look at Sino Forest for example, where sophisticated financial and legal professionals performed reams of expensive due diligence to the tune of a $6 billion market cap only for the entire organization to collapse as a ‘ponzi’ scheme. Canada isn’t a ‘nanny state’ nor is it anti-business, so while public market activity marches, what about crowdfunding?

The larger issue facing consumers is the risk of failure inherent with any new business venture, however this is expected risk and the crowdfunding industry will play a strong part in educating consumers by advising them of the various risks to their capital. There are over 60+ Canadian portals and a growing list of providers looking to help and NCFA Canada is working to provide best practice education for SME issuers, investors and industry stakeholders with partnering sponsors.

Tools such as duration based page-timing, online testing, cooling off periods, and double opt-in consent provisions can be employed to educate participants of risk and maintain a verifiable record that investors were informed and consented to bearing that risk.

Innovation is an iterative process that requires effort and failure to germinate success, increase productivity and affect breakthrough change

Innovation doesn't occur in a vacuum yet CAMP A would have us believe that failure is a bad thing. For the rest of us in CAMP B, we support innovation and understand that crowdfunding will help more projects and ideas get funded than traditional financing allows, thus allowing innovation to iterate and in some cases flourish. Some of those projects will most certainly fail, but some will grow wildly successful in unexpected and rewarding ways.

Although Canada has world class education and thought leaders our ability to innovate and commercialize locally grown businesses is limited, and thus so is Canada's ability to compete on the global stage.

Abraham Lincoln once said, "My great concern is not whether you have failed but whether you are content with your failure". In many ways, our current capital markets and securities laws are failing to provide SMEs with sufficient access to capital resulting in a well documented 'funding gap' (STDC report). Collectively, are we content with this failure?

WHAT CAMP DO YOU SUPPORT?

Crowdfunding is about providing capital to the rest of us - to that broad swath of the Canadian public that doesn’t have friends on bay street, isn’t connected to VC’s from the valley, and doesn’t have their private banker on speed dial. In fact, CAMP A sentiments simply underscore the reality that capital is constrained, and primarily accessible to a very small and select group of people.

Innovation is happening everywhere, and in every group, including those that are typically overlooked by the traditional financiers. However it is often occurring at a small and incremental level, rather than at the ‘home run’ level that CAMP A refers to.

Crowdfunding is certainly not going to be looked favourably upon by ‘wheezy old securities lawyers’ disinterested in rolling up their sleeves to innovate and change the currently expensive process that seems to benefit their practices in the first place. Change requires hard work and effort, and in this case, the beneficiary is the public and small to mid-sized businesses asking for help.

Who’s going to rescue them? Wheezy old securities lawyers; or new, dynamic online investment communities powered by crowdfunding markets and new technologies. You know which camp gets NCFA Canada's vote. How about you?

Resources and Links:

Stay tuned for Dispelling Myths #5 and #6!

The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada crowdfunding hub providing education, advocacy and networking opportunities in the rapidly evolving crowdfunding industry. NCFA Canada is a community-based, membership-driven entity that was formed at the grass roots level to fill a national need in the market place. Join our growing network of industry stakeholders, fundraisers and investors. Increase your organization's profile and gain access to a dynamic group of industry front runners. Learn more eBrochure | Prezi or contact us at casano@ncfacanada.org.